Tom Szabo auf silveraxis zu Prof. Fekete, "leasing" and "lease" rates. Er setzt da einen anderen Schwerpunkt:
With respect to physical demand in silver, I believe we are seeing some of the predictions I recently made about "lease" rates come to fruition. Prof. Fekete explores this issue from another angle in Exploding The Myth Of Silver Shortage, which is a searing counterpoint to Ted Butler's understanding of the futures market as being a downward manipulation of silver by naked shorts. The argument made by Prof. Fekete is full of nuance and I wish that I had the time to fully distill it. For now, I will just say that Prof. Fekete may only be partially right about the claim that negative "lease" rates in silver indicate an abundance of silver supply in the face of short covering in the "leasing" market. The main quibble I have is that the "leasing" market for silver seems to have become rather small as compared to gold, so much so that "leasing" activity is unlikely to have much influence on "lease" rates. How can this be, you ask? Recall from my discussion two weeks ago that "lease" rates in gold and silver are merely the difference between the market rate of interest (LIBOR) and the Forward Offered rate (an annualized percentage gain/loss representing the price at which metal can be contracted for future delivery; in other words, the futures price).
It stands to reason that if silver "leasing" is a minor component of the silver market, then it would have little influence on the Forward Offered rate (and certainly zero influence on LIBOR). Instead, I would posit that the negative "lease" rate in silver is the result of the Forward Offered rate climbing above LIBOR for reasons unrelated to "leasing". For this to be the case, forward or futures demand for silver would need to be higher than spot demand. Yet the unwinding of a "lease" requires spot demand and futures supply, which creates downward pressure on the Forward Offered rate. Alas, this is the exact opposite of what has been observed. So what is going on here? Well, most likely exactly what Prof. Fekete has surmised: a panic short covering. But not in silver "leases". Instead, in the COMEX futures themselves. In fact, we have corroboration for this by way of the Commitment of Traders report, which shows the net commercial short position declining to its lowest level in quite some time. This decline appears to have bottomed and reversed over the past two weeks, but it is nowhere near the extreme that has been reached in gold (more on that in a moment).
So why has silver "leasing" become benign in the scheme of things? Simply, I believe most silver "leases" were unwound in early 2006 prior to the launching of the iShares silver ETF, SLV. Sure, some "leases" have remained, and a majority of these may even have been unwound in the past few weeks just as the Professor reckons. But it is precisely the lack of much (remaining) influence of silver "leasing" on either the futures or spot markets that proves that the level of "leasing" -- and therefore the amount of short covering by "lessees" -- was minor in the first. Instead, I would point to early 2006 and the large fluctuation in "lease" rates back then, along with a massive increase in commercial short positions that topped out well before silver peaked in May, and most importantly, the sustained backwardation in the silver market that lasted several weeks, as an indication of a truly significant episode of liquidation of silver "leases". The May 2006 episode may very well have illustrated the ability of the underground supply of investment-grade silver to satisfy short-covering demand in contrast to the current episode which was weak in comparison. The fact that silver "lease" rates did not turn negative last time is explained by the tremendous amount of physical demand that was present in the silver market as speculators were jockeying for position with long-term market participants who were trying to convert from serial silver "lessees" to newly fanged ETF arbitrage players.
But please don't confuse the waning influence of silver "leasing" with the importance of the message transmitted by "lease" rates. As a proxy for the "interest rate" on bullion, "lease" rates still indicate the sentiment of market participants even if there is not much actual "leasing" going on. Remember, the "lease" rate is nothing more than the difference between the market rate of interest and the percentage return on gold or silver to be delivered at a future date. Think of it this way: a "lessor" could replicate a "lease" by selling gold and silver in the spot market and investing the cash proceeds in the money market, while buying a forward contract that guarantees a fixed price for repurchasing the metal at some future date. Obviously, as long as the forward rate on bullion is lower than the money market rate, you can make money this way and somebody or another will be "leasing" metal. On the other hand, negative "lease" rates don't necessarily mean "leasing" will be suspended altogether. Making money may not be the only reason to "lease" gold or silver; "leased" bullion also represents a very robust form of liquidity. In this sense, a negative "lease" rate can be thought of as a cost of obtaining liquidity. Under some circumstances (such as the past few weeks), some silver owners may have been willing to incur just such a cost in the search for liquidity during an incipient credit crunch. Yes, I am basically building a case for why silver "leasing" might perhaps have even increased during the past few weeks, as this would certainly be consistent with recent COMEX activity and price action.
Before wrapping up what is turning out to be another excruciatingly long lecture on metal "leasing", I would like to point out that some "lessees" in this market are almost completely indifferent to lease rates, just as some liquidity-strapped "lessors" are willing to lend even when rates are negative. To understand this, assume that the "lessee" borrows gold or silver, sells it, invests the proceeds in the money market, but "forgets" to hedge its obligation to return the gold or silver at a future date. Why might he, she, or it do this? Fearlessness, stupidity, ego; take your pick. Or, a gold/silver producer or similar party who will come into possession of bullion at some future date. In other words, "leasing" allows a party who will hold, and be in a position to sell, bullion at some future date to essentially borrow money against such future bullion sale at a rate equal to LIBOR (this is because such "lessor" pays the "lease" rate but is also foregoing the forward premium since the future bullion sale will represent the return of "leased" metal and thus will not generate any cash). As such, there is a whole category of potential "lessees" that is not sensitive to "lease" rates at all, whether they be negative or wildly positive.
In particular, I'm talking about mining companies that might be using "leasing" to generate cash flow in advance of production. An alternate form of this has already been tried: the Silver Wheaton and Silverstone business model of buying future "silver streams" for an up front lump sum and fixed future cost. But as I will point out in the next few days with the help of a surprising source, such a business model may not be as great as the hype. The "leasing" market, on the other hand, provides a very similar outcome if only for a maximum of 12 months of forward production. Interestingly, this is precisely what Prof. Fekete is talking about in his Peak Gold series--legitimate hedging being limited to 12 months due to unlimited risk lying beyond. This topic will be explored at much greater length during the Professor's third session of Gold Standard University Live next February in Dallas. Far from being an academic exercise, it could turn out to be a revolutionary summit on the future of hedging in the mining industry.
Okay, back to silver and COMEX short covering at long last. The fact that short covering on the COMEX may have been possible, and may even have amounted to a panic without causing silver prices to skyrocket, is a direct affront to Ted Butler's theories about the silver market. In regard to "leasing", Prof. Fekete states such an outcome would be possible because there is actually a larger supply of investment silver than most analysts think exists. I myself have toyed with this idea and would be willing to consider the possibility that perhaps 1.5 billion ounces of investment-grade silver might be out there (including COMEX and ETF stockpiles). Alas, the COMEX short covering occurred almost entirely in paper silver: less than 20 million ounces were delivered under the September silver contract. This was a large number by historical standards and possibly one of the largest ever for a September delivery, but 20 million ounces is not massive even by comparison to the 75 million ounces of registered silver currently held in COMEX warehouses. In effect, the silver market was easily able to contain what might have amounted to a short-covering panic on the COMEX. True, the alleged panic occurred during relatively stable silver prices, but that is exactly Prof. Fekete's point!
On the other hand, please don't dismiss Prof. Fekete as a silver bear. If you read his paper carefully, you will note that he believes there is less silver available for monetary purposes, on a relative basis, than there is gold. This, of course, is no daring statement considering central banks hold a lot of the world's gold but virtually none of its silver. Yet I have never seen this state of affairs twisted around so neatly to explain why gold should still remain far superior in terms of monetary value (to the tune of 15:1 or more) even though this is not the actual ratio available for monetary purposes (in effect, there is more gold than silver). To be clear, Prof. Fekete argues that the price ratio of gold to silver is currently too high, but it will never approach parity due to monetary considerations that make gold inherently more stable, and therefore more valuable. I consider this a novel but logically pure explanation of the future price appreciation potential of silver vs. gold. I find it unsurprising, therefore, that at least one admirer of Mr. Butler's work, who also happens to be a fierce critic of Prof. Fekete, has admitted that he does not understand the concept in the least bit.
In any case, today's discussion may have even larger implications for gold "leasing". As previously mentioned, the unwinding of a "lease" should result in a detectable liquidation of commercial long positions, or alternatively a sizeable increase in commercial short positions at the same time as there is new demand in the spot market. Thus, all other things being equal, the spot price of gold rises, the gold basis falls and the net commercial short position in gold balloons. Wait a second, isn't this exactly what is happening in the gold market right now? So, is it possible that gold "leases" are the ones being unwound in a panic, instead of silver "leases"? We already know that gold "leasing" is still a big business with central banks accounting for the vast majority of the "leased" supply (anywhere from 7,000 to 15,000 tons, depending on who you believe). Could it be possible these gold "leases" are now being liquidated, accounting for the disappearance, and even inversion, of the spread between gold and silver "lease" rates? If so, could this be an indication that silver is playing catchup to the monetary status already enjoyed by gold? But wait a second, I just said there might be more "leasing" demand, not less, during a liquidity crisis. Thus, it must be the "lessors" who are reducing the supply of gold available to "lease", to the chagrin of desperate "lessees" looking for easy (if not necessarily cheap) money. This makes sense considering who the "lessors" are: the central banks. Yes, the very same central banks that appear to have sold less gold this year than permitted under the Washington Agreement.
As I postulated two weeks ago, a negative "lease" rate may be a pre-condition for gold and silver returning to monetary recognition. And where else for monetary recognition to begin than with the central banks themselves? As this recognition spreads, both gold and silver "lease" rates could very well turn negative on a temporary basis. Some will call such developments a head fake and others will blame the central banks and bullion banks for tricking the public, but you and I will know better.
h.
